With global policy rates ratcheting higher amid inflationary pressures, market participants are looking closely at the impacts of interest rate movements on various parts of their portfolios, including Value equity. Research shows that the relationship between the Value factor premium1 and interest rate fluctuations has strengthened significantly since the global financial crisis (Figure 1).2
This rising correlation seems to lend support to a popular view that Value investing is simply an interest rate bet. Many prior literature, on the other hand, find that such correlation does not hold steady over time, and over the past decade, some other Value-related ratios (such as dividend yield) have exhibited a much weaker relationship with rates. However, prior literature fails to provide any fundamental reason for the changing correlations and tends to attribute them to simple statistical randomness.
"In our view, the recent strong correlation between the Value factor premium and rates is likely driven by changes in sector concentration in Value style indices."
The financial sector has become more concentrated in the top book-to-market quintile (i.e., the deepest Value quintile), and as a result, the interest rate beta3 of the book-to-market factor has risen.